The financial crisis gripping the UK care home sector

What are the key pressure points putting care homes at risk of financial failure? Steve Parker, a licensed insolvency practitioner and a partner at Opus Restructuring and Nick Hood, business risk analyst at Company Watch, share their views.

Original news

Press release: Care home sector strengthens, but one in four care home businesses is still financially vulnerable : http://www.companywatch.net/wp-content/uploads/2014/02/Company-Watch-One-in-four-care-homes-still-financially-vulnerable-20140228.pdf

Updated research into the financial health of UK care home companies from Company Watch, specialists in tracking and predicting corporate financial health worldwide, confirms that despite some signs of improvement in the sector, almost a quarter of carehome operators are in its Warning Area six months on from its original study.

What does the latest Company Watch report reveal?

The parlous state of the finances of the UK's 20,000 care homes was first revealed last summer when Company Watch published research showing that almost a third of care home operators were in their Warning Area--indicating heightened risk of insolvency or a major restructuring (see Press release: One in three care home businesses are financially vulnerable).

Now Company Watch has updated its statistics, analysing the latest accounts of 5,037 companies which operate care homes. They found that despite some marginal improvements, nearly a quarter are still financially vulnerable and worse still, that 682 of them have negative balance sheets with debts higher than their assets.

Another adverse finding is that borrowings across the entire care home sector average 75% of net assets, an abnormally high level linked originally to buying the properties in which the homes are located but now pushed ever higher by trading losses. The exposure this causes to the widely anticipated rise in interest rates during in 2015 or even sooner is obvious.

Why are so many care homes in trouble?

The problem at the core of the care home business model is a pernicious squeeze on profitability caused on one hand by falling income from fees paid by local authorities for the great majority of residents, which have been driven down by government austerity measures. On the other side of the equation, costs are rising either because of demands for higher care quality or factors outside an operator's control, such as rising energy prices or increases in the national minimum wage.

The result is that the average annual profit earned by each of the 5,037 care home operators examined by Company Watch was only £52,000. Even assuming profits do not fall further as seems most likely, this is hardly a basis for the investment required to improve standards, never mind to create of the 120,000 extra places which demographic trends dictate will be needed to deal with the surge of ageing baby boomers who will require care in the medium term.

What happens when a care home fails?

Fortunately, outright failures of care homes are relatively rare because of the practical difficulties this causes and the extreme lengths to which the interested parties, especially the relevant local authority, will go to avoid the risks of elderly and vulnerable people being exposed to any major disruption to their lives. However, significant numbers of homes are being rescued outside a formal insolvency procedure by finding new owners and negotiating debt forgiveness. The challenges for specialist turnaround experts are considerable--not least the legal and regulatory hoops through which they and their legal advisers have to jump.

The worry looking forward is that if interest rates do rise and if the proposed 3% rise next October in the minimum wage, which affects a large part of the cost base for homes, cannot be offset by a commensurate increase in fees, then the rate of financial distress will increase.

The potential social Armageddon of mass failures was highlighted in 2011 by the collapse and subsequent rescue of the Southern Cross group, which operated 750 homes. The finances of all of the major care home operators are now closely monitored by the Department of Health and there have been two recent cash injections by private equity houses into major care home groups, demonstrating that financial issues can be addressed if the opportunity for the investor is sufficiently large.

Which care home operators are most at risk?

The focus for future difficulties is much more likely to be on the legion of operators with just one or a small handful of homes, especially in rural locations. The logistics of rescuing any volume of these will be the major issue, not the financial aspects. A particular problem will be finding sufficient operational and management expertise to replace the departing owners. In the past, local authorities ran homes themselves and had a pool of resource which could be mobilised to help with such emergencies. Now that homes are almost exclusively in private or charitable hands, this extra capacity has been dissipated. There are only a small number of specialist agencies, who would surely struggle to deal with any significant surge in failures.

There is no magic bullet which will return the care home sector to the secure financial footing that residents, their anxious relatives and society should be entitled to take for granted as normal. Instead, operators will continue surviving on a hand-to-mouth basis and earning a pittance. We can only hope that they see this as the vocation it has become for most and be prepared to carry on. But some operators will leave the market and, sadly there will be more commercial casualties.

Interviewed by Kathy Stones.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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